Bank rules may be a factor in higher funding costs, says RBA

The central bank has warned that the foreign appetite for Australian financial assets and new global banking rules could force up bank funding costs and hit the broader economy.

In a quarterly bulletin yesterday, the Reserve Bank of Australia said it might need to change policies to counter the risk. It said the pressure on high-quality liquidity assets might require further developments in ­policy.

Demand for high-quality liquid assets such as Commonwealth bonds, debt-issued by the federal government, would rise significantly because of banking regulation Basel III that requires financial ­institutions to hold a stock of liquid assets as a safeguard.

Also, additional regulations to curb the risks of trading over-the-counter (OTC) derivatives by posting more security against positions, would add to demand for high-quality bonds, driving up the price of these increasingly scarce assets, it said.

The RBA estimates the new OTC requirement could require Australian banks to find an extra $35 billion of collateral.

“To the extent that increasing demand for eligible collateral assets drives up the price of those assets, banks’ costs of funding and the costs of trading would be expected to rise," the RBA bulletin states.

“This could, in turn, lead to a decline in key financial activities, such as foreign exchange and interest rate hedging, which support many transactions in the broader economy."

Commonwealth bonds, which are preferred collateral due to their creditworthiness, are already among the most scarce in the world relative to the country’s gross domestic product.

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Also, strong demand from offshore sovereign wealth funds and central banks for AAA-rated Australian government debt has produced fierce competition in the Commonwealth bond market and driven yields to record lows.

“There’s a limited stock of bonds and Australia is a bit of a safe haven at the moment," Australian Bankers’ Association policy director Tony Burke said. “Banks are competing with everybody to acquire these ­securities."

The RBA did allay some fears about a potential liquidity seizure in the Australian government bond market by creating a “committed liquidity facility" in 2011, that will allow banks to exchange a broader range of assets for liquidity in times of crisis.

However, the RBA will charge a “penalty rate" on assets that do not qualify, making it more expensive for financial institutions that hold fewer Commonwealth bonds.

The RBA also wrote: “The impending increase in demand for collateral eligible assets arising from regulatory reforms in the market for OTC derivatives may require a flexible response from the RBA – and indeed other central banks around the world."